We’ve talked about the FED driving the car from one ditch to the next, by raising rates too far and keeping them there too long or lowering them too far and leaving them low for too long.
As we said in the past, we think the FED should be done raising interest rates. As a matter of fact, we said that at 5% they should have been done. But they continue to look at their lagging data to tell them where their interest rate policy should be.
Why do they look at lagging indicators? You got me. In fact, let’s take a look at what leading and lagging indicators are saying at the moment. The following chart is provided courtesy of Ed Yardeni.
You can see that the leading indicators turned down in 2022 (FED started raising rates March 2022), but meanwhile, the lagging index is heading higher. Why, you ask? Because the components of that index have not rolled over yet (hence lagging). A couple of the big components would be CPI and Unemployment Rate. Guess what two inputs the FED uses. Yep you guessed it, CPI and Unemployment. Any small wonder why they are still considering raising interest rates at this point? They are basically looking at the lagging indicators still going up and saying that the economy is still in good shape. But the leading indicators are saying the exact opposite.
So, savings has been depleted (for the most part) and credit card balances are at all time highs (with interest rates sky high too), so yeah, the economy still looks good at this moment. People have been spending excess savings and charging on their credit cards in order to keep their lifestyles at the levels they are used to. The problem is real wages are down since COVID (meaning less money to spend after inflation). Here’s a chart.
This next chart shows the 2yr/10yr yield curve. Everyone talks about the “inversion” of the yield curve, but that’s only half the story. Yes, typically when the 2-year treasury is higher than the 10-year treasury, that usually says that an economic slowdown is coming. And it does a pretty good job.
You can see, that when the blue line crosses below the 0% black line, a shaded section happens not too long after (shaded are recessions). I would contend that we would have had a recession in 2020 with or without COVID. I’ll also say that COVID was a great cover for the massive spending that happened in the wake of the pandemic (and honestly is still happening). Except you do have one thing different this time than you’ve had in the past 20+ years, and that would be the backdrop of inflation. Low inflation has allowed the Federal Reserve to lower rates and stimulate the economy without the real negative effect of producing inflation. This time we have inflation. Yes, it’s coming down and yes it is likely to go below the 2% level if/when we have a recession. If, however, the FED decides to change course and stimulate without really destroying inflation (which I don’t think they can because of demographics), then we will see inflation come back. That’s the rock and the hard place they are stuck between.
Now, they have steadfastly said that they are going to hold interest rates high until inflation is tamed. Check out this quote from the Jackson Hole summit (Aug 24-26) we were all invited to 😊.
Here is the FED’s statement from September 20th.
Now that we have seen the FEDs resolve, let’s take a closer look at the 2/10yr chart. If you look closer, you will see that not only did the curve go negative (below the black line) prior to a recession, it started to steepen (move back toward the black line and even move positive) before the recession started.
Guess what’s happening now? You guessed it, the curve is steepening. Will it go positive before a recession? I doubt it, because short-term rates are highly influenced by the Federal Reserve. They won’t start cutting rates until they know inflation has been tamed. But inflation won’t be tamed until an economic slowdown is already here. Remember, CPI is a lagging indicator.
So, being focused on CPI will cause the FED to drive the car into the next ditch. Maybe I’m wrong and we can have a $33 trillion debt, with interest payments that consumes 15%-20% of our GDP, housing affordability at a historically high level, student loan payments starting again, credit card balances the highest in history, and auto loans averaging over $750/month Oh, did I forget that we have made promises to seniors and retirees to cover their medical and provide a base retirement income, both of which will be insolvent by 2031 (only 8 years from now)?
Even if all those things mentioned above are obstacles, I do still think the FED will try to kick the can down the street one more time. Will it work? Depends how messed up our car is after we pull it out of the ditch.
This must be why they have the Economic Summit in Jackson Hole in the summer. This is what it would look like being held in January.
I hope you have a good week, and please let us know if you have any questions.